CWS Market Review – June 10, 2011

On Thursday, the stock market finally stopped its six-day slide. We have to go back more than two years to find the last six-day losing streak. The S&P 500 gained 0.71% on Thursday to close at 1,289. The big gainers on the day were stocks in the Energy, Materials and Financial sectors—exactly the areas that have been getting punished the most recently.

As I’ve been warning investors, the market is rotating out of these economically sensitive stocks and seeking shelter in lower-risk areas. For example, Reynolds American ($RAI), our highest-yielding stock on the Buy List has our second-best capital gain for the year. Another example is that the yield on the two-year Treasury recently dipped below 0.4%. That’s about one-fifth the yield of the S&P 500. Even longer-date maturities are benefiting. The 10-year note got down to 2.92% which is the lowest yield since December 3rd.

So is this a turnaround for the stock market? Perhaps. The week isn’t over yet but we have a good shot of making it six-straight losing weeks. To be fair, that number is a bit misleading since some of the weekly losses have been very slight.

Let’s add some important context here. The S&P 500 is still higher than where it was 12 weeks ago. While the 2.28% plunge on June 1st was unpleasant, there’s no reason to expect the entire market to roll over from that. In fact, there have been 19 days worse than that since the bull market began 27 months ago, and the bull charged over every single one.

When we look at longer drops—the S&P 500 shed 6.16% from April 29th to June 8th—we see that there have been four corrections larger than that in the last two years. That includes an ugly 15.99% drop last year. Once again, the bull overcame all of them. Bloomberg reported that the S&P 500 is at its “cheapest valuation since August.”

In last week’s issue, I noted that the S&P 500 had been in a very tight trading range. Thanks to the recent slide, we broke the lower bound but not by much. Right now, I’m keeping a close eye on the S&P 500’s 200-day moving average which is currently at 1,252. I’m not much for technical analysis, but I’m curious to see if we make a run at the 200-DMA. The S&P 500 hasn’t gone below its 200-DMA in nine months.

The important fact all investors need to understand is that earnings are strong but growth is slowing down largely because the comparisons are getting tougher. It’s not hard to put up 20% or 30% growth numbers when the S&P 500 earns $49.51 as it did in 2008. But nowadays, the comparison bar is set much higher.

With 99% of the earnings in for the first quarter, the S&P 500 has earned $22.58 which is a hefty 16.51% jump over Q1 2010. There are only three weeks left in Q2 but when all the numbers are in, the S&P 500 has a very good chance of posting record quarterly earnings. You wouldn’t know that from looking at the news recently. The old earnings record was set in the Q2 of 2007, yet the S&P 500 is 14.5% lower than it was four years ago. It’s no surprise that we recently learned that bearish sentiment has soared among individual investors.

Wall Street has been rattled by a series of poor economic reports. Last Friday’s jobs report was especially disheartening. Even though the recession officially ended two years ago, the jobless rate is still at 9.1%. What’s especially troubling is that the number of people who have been employed for an extended period remains stubbornly high.

There are some causes for optimism. Looking at the details of the jobs report, we see that there were 29,000 fewer government jobs in May. That means the private economy created 83,000 new jobs. Furthermore, the lousy weather and disruptions in Japan weighed heavily on the jobs market. Thursday’s trade report showed that imports from Japan plunged 25.5% last month. That certainly won’t last. Fed Chairman Ben Bernanke said on Tuesday, “I expect hiring to pick up from last month’s pace as growth strengthens in the second half of the year.” That’s nice to hear, but I want to see proof before I know it’s real.

Despite this outbreak of bad economic news, Wall Street is sticking to its optimistic earnings forecast for this year and next. For 2011, analysts see the S&P 500 earning $98.03, and for 2012 they expect earnings of $111.82. That’s a forward P/E Ratio of 11.53 which is very low. (I should add that I’m a little leery of forecasts that go out so far. I’m mentioning this to show you how fearful Wall Street is.) The good news for us is that our strategy of buying and holding top-qualities continues to do well. For the year, our Buy List has gained more 5% which is more than double the S&P 500.

With each issue of CWS Market Review, I like to point out stocks on our Buy List that look especially attractive at the moment. The recent sell-off has given us several solid values. Ford ($F), for example, recently dropped below $14 per share which is a very good price. The company spoke to analysts this week and outlined ambitious plans for the next few years. Several of my old favorites like AFLAC ($AFL), Nicholas Financial ($NICK) and Moog ($MOG-A) are also excellent buys.

This is a fairly quiet time for the stock market. In fact, there won’t be much important news until the second-quarter earnings season begins in another month. We have two Buy List stocks that are due to report earnings soon since their quarters end with the close of May. Bed Bath & Beyond ($BBBY) will report earnings after the close on June 22nd, and Oracle ($ORCL) will report the next day.

In April, BBBY said it expects fiscal Q1 earnings of 58 to 61 cents per share. My take is that that’s on the low side. I’m expecting a modest earnings surprise—around 63 cents per share, give or take. I hope to see Q2 guidance of 80 to 85 cents per share. For now, I’m keeping my buy price at $55 per share. BBBY is a very well-run company.

I like Oracle a lot especially now that the shares are down over the last two months. The company reported very strong earnings three months ago; revenues rose 37% and earnings topped expectations (which I predicted). In March, Oracle said to expect earnings for the May quarter to range between 69 and 73 cents per share (that compares with 60 cents for the same quarter one year ago). That’s actually surprisingly aggressive so I can’t say I’m expecting a big earnings beat. Still, the company is very sound and I also like their clean balance sheet. Oracle is a strong buy up to $34 per share.

That’s all for now. Be sure to keep visiting this blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on June 10th, 2011 at 7:35 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.